Wednesday, April 09, 2008

The 64,000 euro question

"Why do Foreigners Invest in the United States?" by Kristen Forbes. NBER working paper (ungated version here). Her answer is bad news for us; she says it's because of our highly developed financial markets!!

Here's the abstract:

Why are foreigners willing to invest almost $2 trillion per year in the United States? The answer affects if the existing pattern of global imbalances can persist and if the United States can continue to finance its current account deficit without a major change in asset prices and returns. This paper tests various hypotheses and finds that standard portfolio allocation models and diversification motives are poor predictors of foreign holdings of U.S. liabilities. Instead, foreigners hold greater shares of their investment portfolios in the United States if they have less developed financial markets. The magnitude of this effect decreases with income per capita. Countries with fewer capital controls and greater trade with the United States also invest more in U.S. equity and bond markets, and foreign investors “chase returns” in their purchases of U.S. equities (although not bonds). The empirical results showing a primary role of financial market. development in driving foreign purchases of U.S. portfolio liabilities supports recent theoretical work on global imbalances.

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